On January 2, 2013, following a heated political showdown that fleetingly steered the nation over the so-called “fiscal cliff," President Barack Obama signed into law the American Taxpayer Relief Act of 2012 (Act). Much to the relief of those who procrastinated on their 2012 estate planning, the temporary $5 million estate, gift and generation-skipping tax exemptions have been made permanent (indexed for inflation), along with the portability of the unused estate tax exemptions between spouses. The only change from the favorable rules that were applicable in 2012 is that the top estate, gift and GST rates have all been increased from 35% to 40%.
From an income tax perspective, although the Act specifically defines the new income tax brackets applicable to individuals, the Act itself is silent on the brackets that will now apply to estates and trusts. On January 11, 2013, the Internal Revenue Service (IRS) issued Rev. Proc. 2013-15, which provides guidance on this matter.
The 35% top tax bracket for estates and trusts that existed under prior law has been eliminated. Under the new regime, all income in excess of the 33% tax bracket ceiling, which has been adjusted to $11,950 for the year 2013, will now be taxed at 39.6%. This low threshold stands in stark contrast to the newly established 39.6% top bracket for individuals, which is triggered only for single taxpayers and joint filers with taxable incomes in excess of $400,000 and $450,000, respectively.
The Act also contains provisions that impact the taxation of capital gains and dividends. Affected individuals and fiduciaries should be pleased that qualified dividends received by estates and trusts will continue to be taxed at favorable capital gains rates. However, the maximum capital gains tax rates will increase from 15% to 20% for estates and trusts that are subject to the top tax bracket.
Beginning after December 31, 2012, estates and trusts will continue to pay no tax on adjusted net capital gains and dividends if such gains and dividends would otherwise be subject to the 15% ordinary income tax rate. A dividend and capital gains rate of 15% will remain in effect for adjusted net capital gains and dividends if such gains would otherwise be subject to the 25%, 28%, or 33% ordinary income tax rates. New in 2013, a dividend and capital gains rate of 20% will apply to the adjusted net capital gains and dividends of estates and trusts if such gains and dividends would otherwise be subject to the 39.6% ordinary income tax rate, which takes effect for income in excess of $11,950.
In addition to the increased dividends and capital gains rates, higher income taxpayers will also be subject to a 3.8% Medicare surtax on net investment income in 2013 to the extent certain income thresholds are exceeded. The threshold for trusts and estates is $11,950. By contrast, the Medicare surtax will impact married taxpayers filing joint returns only if their modified gross income exceeds $250,000.
The disparity between the maximum tax bracket thresholds applicable to individuals and those applicable to estates and trusts illustrates the need for judicious planning on behalf of executors and trustees. Available techniques include the careful timing of distributions so that income is shifted from the entity to the individual beneficiaries, where the income may be shielded from the higher rates by means of the individual’s lower marginal tax bracket. However, each family has its own unique circumstances and needs, and there is no one-size-fits-all solution that can be applied across the spectrum. Our experienced professionals are prepared to evaluate your situation and to recommend customized strategies that may be used to maximize your tax savings.
H.R. 8 (112th): American Taxpayer Relief Act of 2012
Rev. Proc. 2013-15
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